I’ve recently discussed the strong (inverse) correlation between the US Dollar and gold prices along with my thoughts that both gold & the dollar are likely to reverse course soon. In the previous update showing the $USD (US Dollar Index) 20-year monthly chart, I had stated that next solid monthly close above or below the large symmetrical triangle pattern would most likely determine the next major direction in gold. As of the close on Tuesday (Sept month end), the $USD did print a solid close above the triangle pattern, certainly a bullish technical event on face value. Although I continue to hold off on adding any exposure to gold or the mining sector, I have yet to throw in the towel at this point either.

There are a few reasons for not writing off gold at this time nor jumping on board the crowded “bullish $USD” bus just yet. First of all, as of today, despite the recent breakout in the $USD, gold (GLD) has just fallen to test the mid & late 2013 lows, thereby completing the triple-bottom scenario that I’ve been discussing as a possibility for many months now. I also continue to remain open to the possibility of a brief washout break below those previous lows before a lasting bottom is finally hammered out in gold but again, I’m just not confident enough to add any more exposure to the metals or miners until I see some decent technical evidence of a reversal in gold (and silver) prices.

Another reason that I have not yet jumped on the bullish dollar bandwagon, despite the recent breakout above the long-term downtrend line in the dollar index is two-fold. First, the $USD has significant horizontal resistance just overhead to contend with. The monthly $USD chart below is an EOD (end-of-day) chart and has yet to reflect today’s sharp rally in the dollar but the UUP (Dollar Index Tracking ETF) weekly chart below does a fairly decent job of tracking the index and shows today’s move pushing into the resistance zone. Finally, the $USD Index is simply a sum of its parts. In fact, although the $USD is comprised of a basket of six currencies, the top two largest components account for over 70% of the performance of the index: The Euro at a very top-heavy 57.6% weighting, followed by the Japanese Yen at a 13.6% weighting. Therefore, where the Euro & Yen are heading will most certainly determine the future path of the US Dollar Index.

 

The chart below is a 10 year weekly chart of the $XEU (Phily Euro Index). What stands out to me on this chart is the fact that the $XEU is only about 2 1/2% above a major multi-year uptrend support line which defines the bottom of a large triangle pattern. Not only are prices just above a major support level but the $XEU is also at rarely (if ever) seen oversold levels on the weekly RSI. Although admittedly we have a small sampling of such readings reference, previous such readings were followed by very powerful trend reversals (bull markets) as shown by the blue circles & shaded arrows.

$XEU (Euro) weekly Oct 3rd

$XEU (Euro) weekly Oct 3rd

 

These next charts are the 10-year weekly charts of the $XJY (Phily Yen Index) & the USD/JPY (Dollar/Yen pair). The $XJY chart shows strong bullish (positive) divergences forming as the Yen works its way down within a bullish falling wedge/contracting channel-type pattern as it has also fallen to a minor support level. The USD/JPY chart shows the pair approaching the 2008 reaction high (likely to act as resistance) with strong bearish divergences forming on the PPO & RSI, thereby indicating that the odds for a reversal in the pair is quite elevated at this time.

 

The bottom line is that the recent, well-watched breakout in the US Dollar very well may lead to a sustained and powerful move higher in the dollar and if so, gold and the mining stocks are likely heading much lower as a result of a strengthening dollar. However, until & unless these potential bearish developments on the Euro & Yen are negated (i.e.- prices clearly take out those support & resistance levels, taking out the bearish divergences in the process), my continued expectation is for an imminent & sustained trend reversal in the US Dollar Index and a new uptrend in gold prices from at or somewhat below current levels. However, my confidence in this scenario is not as high as I’d like it to be in order to position aggressively and as such, I will wait for some decent evidence of this expected trend reversal before adding any more exposure to the metals & miners.

“The expected never happens; it is the unexpected always.”
— John Maynard Keynes